Galaxy Strategy: Energy Shock Is Only the Beginning; U.S. Debt Faces a Severe Test

Key Takeaways

Escalation in the U.S.-Iran conflict continues, with military strikes and diplomatic maneuvering running in parallel. Iran targets U.S. and Israeli objectives through multiple rounds of strikes by restricting passage through the Strait of Hormuz and continuing actions under “True Commitment-4”; in response, the U.S. and Israel expand airstrikes on Iran’s military and infrastructure. U.S. President Trump has made tough remarks on multiple occasions, saying military action has achieved “decisive victory,” and threatening to strike Iran’s energy facilities if negotiations fail, while also proposing reopening the Strait of Hormuz as a condition for a ceasefire. During the period, incidents involving combat losses such as U.S. military aircraft being shot down have occurred. The spillover risk from the conflict has extended to the Gulf and many countries in the Middle East, and the overall situation remains in a phase of mutual stalemate.

The core drivers of global market volatility this week still come from the Middle East geopolitical conflict and energy shocks. With Iran’s fighting remaining deadlocked and passage through the Strait of Hormuz disrupted, market concerns about a possible global interruption in crude oil supply have risen, pushing WTI crude oil prices to record highs and also lifting energy and some resource prices overall, while raising potential inflation expectations as well. Against this backdrop, precious metals and some industrial metals have strengthened in sync. Meanwhile, with energy shocks compounded by inflation uncertainty, major central banks remain cautious about policy shifts: Fed officials have generally signaled that they will keep interest rates unchanged, but U.S. Treasury yields have fallen overall. In equities, U.S. nonfarm payroll employment came in clearly better than expected, and active capital operations in the technology sector supported market sentiment, enabling U.S. and European stock markets to rebound after midweek fluctuations. By contrast, China’s equity markets were relatively weaker due to adjustments in growth sectors and a pullback in risk appetite.

The oil crises of the 1970s showed that when energy prices rise sharply and policy responses are hesitant, supply shocks can easily evolve into a stagflation pattern. At the time, OPEC’s production cuts led oil prices to jump by roughly four times in the short term. During the chairmanship of Federal Reserve Chair Arthur Burns, the Fed treated this as a non-monetary shock and did not tighten policy in time, ultimately causing inflation expectations to lose their anchor and resulting in a wage–price spiral. Only after Paul Volcker implemented extremely tight monetary policy was inflation brought back under control, but at the cost of a severe recession. Compared with the 1970s, energy intensity in today’s developed economies has fallen significantly, and supply sources are more diversified. Meanwhile, artificial intelligence and automation technologies weaken workers’ bargaining power, thereby reducing the probability of a fully formed wage–price spiral taking hold across the board. At the same time, however, elevated public debt levels create new constraints for the current macro policy backdrop.

U.S. Treasury supply expansion combined with weakening demand puts sustained upward pressure on long-end yields. As of March, U.S. federal debt is approaching $4 trillion. In recent months, the expansion pace has clearly accelerated, and together with increased overseas military spending and long-term fiscal deficits, demand for issuing new bonds is still rising. At current interest-rate levels, interest expense is growing quickly, and it may exceed $1 trillion in fiscal year 2026. The demand side is also changing: high inflation suppresses real returns, and overseas major holders such as Japan and China showed partial, end-of-2025 reductions in their holdings. At the same time, some Middle Eastern oil-producing countries and emerging markets are gradually pushing ahead with reserve diversification, reducing reliance on a single asset. Against this backdrop, U.S. Treasuries are no longer able—like in the past—to reliably absorb global safe-haven capital. Yields are more easily influenced jointly by increased supply and rising inflation expectations, and the long-end yield “center of gravity” faces upward pressure.

Under the backdrop of high oil prices, high inflation, and high interest rates, the logic of global asset pricing is changing. U.S. Treasury yields are more easily affected by inflation and supply; the long-end yield “center of gravity” faces upward pressure. Gold has allocation value in an environment of inflation and uncertainty, and the upward shift in the crude oil price “center of gravity” is becoming an important constraint. The U.S. dollar is still supported in the short term by safe-haven demand and liquidity, but in the medium term it faces adjustment pressure amid fiscal stress and reserve diversification. The attractiveness of renminbi assets is set to improve: with China farther from the core conflict zone and still having room for policy, and with relatively strong industrial chains and supply capacity, renminbi assets have advantages in the “stability” dimension.

Risk Warning

Risk of geopolitical disturbances; risk of uncertainty in Trump’s policies; risk that overseas rate cuts fall short of expectations; risk that the domestic policy implementation effect does not transmit as expected.

Main Text

I. Follow-up on the U.S.-Iran conflict dynamics

From March 30 to April 5, 2026, between the U.S. and Iran there is still a recurring back-and-forth between military pressure and diplomatic probing, and in the short term no breakthrough progress has yet emerged that could change the course of the fighting. On March 30, the Iranian Parliamentary National Security Commission approved the Strait of Hormuz management plan, announcing that it would ban the passage of ships from the United States and from countries participating in unilateral sanctions against Iran. On the same day, U.S. President Trump stated publicly that if negotiations cannot reach an agreement, the U.S. would destroy Iran’s power generation facilities, oil wells, and key energy infrastructure such as Halk Island located in the Persian Gulf, emphasizing that the U.S. would not allow Iran to obtain nuclear weapons. Meanwhile, Israel launched multiple rounds of airstrikes on Tehran, striking about 40 weapons production and R&D facilities, further raising the intensity of the conflict. On March 31, Iran launched the 88th wave offensive of “True Commitment-4,” striking shipping targets in the Persian Gulf and continuing to conduct long-range strikes against U.S. and Israeli military facilities. That same day, U.S. President Trump said he hoped to end U.S. military action against Iran “within two to three weeks,” and he also pushed for indirect talks with Iran through Pakistan. The U.S. military used a 2000-pound bunker-buster to strike a large ammunition depot in Iran’s Isfahan, while the Israeli military also announced that within the past 24 hours it had struck about 20 weapons production facilities inside Iran.

On April 1, Israel announced that in the past two days it had carried out airstrikes on about 400 targets inside Iran, while Iran fired about 10 ballistic missiles into central Israel, launching the largest missile attack since the start of hostilities. On the same day, U.S. President Trump said that U.S. forces might “soon” withdraw from Iran, and he proposed that if Iran reopens the Strait of Hormuz, the U.S. is willing to promote a ceasefire arrangement. Meanwhile, the U.S. military deployed 18 additional A-10 attack aircraft to the Middle East, doubling the scale of the A-10 deployment in the region. On April 2, Iran launched the 90th wave offensive of “True Commitment-4,” continuing to strike military and industrial targets related to the U.S. and Israel. That day, Trump delivered a nationwide televised address, claiming that U.S. military operations against Iran had achieved “fast, decisive, overwhelming victory,” and stating that if an agreement could not be reached through negotiations, the U.S. would continue to carry out more intense strikes against Iran in the next two to three weeks, and might directly strike Iran’s energy facilities.

On April 3, a U.S. Air Force F-15 fighter jet was shot down over Iran. Two pilots ejected: one was rescued, while the other went missing. Subsequently, two A-10 attack aircraft were attacked—one crashed into the Persian Gulf and the other made an emergency landing. On the same day, Iran announced that in the 92nd wave offensive of “True Commitment-4,” it destroyed U.S. military radar systems and naval equipment, while Israel continued to expand airstrikes against Tehran and surrounding military targets. On April 4, Iran launched the 95th wave offensive of “True Commitment-4,” and said that its air-defense system near the Strait of Hormuz hit a U.S. military A-10 attack aircraft. It also claimed to have shot down an F-35 aircraft and multiple unmanned drones. That day, Iran’s Bushehr nuclear power plant was attacked again, raising regional concerns about nuclear security risks. Meanwhile, signs of further spillover from the conflict became more apparent, with some cities in the Iraq border crossing area and the Gulf region affected.

II. Performance of major asset classes over the week

The core driver of global market volatility this week still comes from the Middle East geopolitical conflict and energy shocks. With Iran’s fighting remaining deadlocked and passage through the Strait of Hormuz disrupted, market concerns about a disruption to global crude oil supply have risen markedly, pushing WTI crude oil prices to record highs and lifting energy and some resource prices overall, while also raising potential inflation expectations. Against this backdrop, precious metals and some industrial metals have strengthened in sync. Meanwhile, energy shocks combined with inflation uncertainty lead major central banks to remain cautious about policy shifts. Fed officials have generally released signals that they will keep interest rates unchanged, but U.S. Treasury yields have fallen overall. In equities, U.S. nonfarm payroll employment was clearly better than expected, and active capital operations in the technology sector supported market sentiment, enabling U.S. and European stock markets to rebound after midweek fluctuations. By contrast, China’s equity markets were relatively weaker, affected by adjustments in growth sectors and a decline in risk appetite.

Specifically, NYMEX WTI rose 12.46%, LME aluminum rose 5.26%, COMEX silver rose 4.83%, LME zinc rose 4.80%, the FTSE 100 (UK) rose 4.70%, the Nasdaq Composite rose 4.44%, COMEX gold rose 3.95%, Germany’s DAX rose 3.89%, Eurozone STOXX rose 3.77%, ICE Brent rose 3.72%, France’s CAC40 rose 3.38%, the S&P 500 rose 3.36%, the Dow Jones Industrial Average rose 2.96%, LME copper rose 1.35%, the FTSE Singapore Straits Index rose 1.01%, the Ho Chi Minh Index rose 0.67%, the Hang Seng Index rose 0.66%, GBP/USD rose 0.31%, CBOT soybeans rose 0.30%, EUR/USD rose 0.06%, the U.S. Dollar Index rose 0.02%, India SENSEX 30 fell 0.36%, USD/JPY fell 0.38%, the Nikkei 225 fell 0.47%, USD/offshore RMB fell 0.48%, SHFE rebar fell 0.77%, the SSE Composite fell 0.86%, the 10-year China government bond yield fell 1 BP, CBOT wheat fell 1.20%, DCE iron ore fell 1.60%, CBOT corn fell 2.16%, the SZSE Component fell 2.96%, the ChiNext Index fell 4.44%, NYMEX natural gas fell 7.21%, and the 10-year U.S. Treasury yield fell 11 BPs.

III. Comparing this round of energy crisis with the 1970s

With the U.S.-Iran conflict continuing to escalate, and shipping risk through the Strait of Hormuz rising, global energy markets have entered a highly sensitive phase. On March 23, the International Energy Agency stated that the potential scale of the energy supply shock in this round could exceed the sum of the two oil crises of the 1970s. Based on historical experience, energy supply shocks are not only an issue of commodity price fluctuations; they can also easily become an important turning point in the macroeconomic cycle. The first oil crisis of the 1970s occurred after the Fourth Middle East War in 1973. OPEC Arab member countries applied energy pressure on Western nations through production cuts and embargoes, and international oil prices rose by about four times in a short period, causing global energy costs to surge sharply. At that time, Fed Chair Burns believed the rise in oil prices was a supply shock rather than a monetary factor, and therefore there was no need for strong intervention via monetary policy. He judged that rising energy prices would gradually ease through supply adjustments and substitution effects. However, this assessment ignored the “second-round effects” of the supply shock. As energy prices rise, companies’ production costs increase significantly; workers then demand higher wages to offset the rising cost of living; and companies pass the costs on to consumers again, forming a loop in which wages and prices reinforce each other, with inflation expectations gradually losing their anchor. By 1974, the U.S. inflation rate had risen to double digits, while economic growth had slowed markedly, and a stagflation pattern began to form.

At the time, U.S. President Nixon and his government continued to pressure the Federal Reserve, hoping to maintain lower interest rates to support economic growth, which meant monetary policy was unable to tighten in time during a critical phase. Similar political intervention was also used in the current context; U.S. President Trump has repeatedly criticized Federal Reserve Chair Powell’s policy stance publicly. Historical experience shows that when an energy supply shock coincides with policy hesitation, inflation is more likely to get out of control. Ultimately, the U.S. only stabilized inflation expectations after Paul Volcker became Fed Chair in 1979, using extremely aggressive rate hikes, but at the cost of a severe economic recession. In a stagflation environment, traditional asset allocation structures often face the risk of becoming ineffective. Because high inflation lifts interest-rate levels, bond prices fall sharply. Meanwhile, slowing economic growth suppresses corporate earnings, putting similar pressure on the stock market. Only after inflation was brought under control in the Volcker era did the long-term bond market begin a sustained bull market lasting for decades. Therefore, historical experience indicates that when an energy supply shock evolves into a stagflation environment, traditional stock–bond allocations are often unable to provide effective hedging.

However, compared with the 1970s, today’s global economic structure also has clear differences. First, energy intensity in developed economies has fallen significantly. Over the past 50 years, technological progress and changes in industrial structure have substantially reduced energy consumption required per unit of GDP, meaning that oil-price rises pose a relatively weaker shock to economic growth than in the 1970s. Second, the global energy supply structure is more diversified. The U.S. shale oil revolution significantly increased production capacity in non-OPEC countries, strengthening supply elasticity in the global oil market. In addition, labor market structure has also changed. In the 1970s, Western countries’ trade union strength was stronger, so rising energy prices could be quickly transmitted to firms’ costs through wage bargaining, further forming a wage–price inflation spiral. In today’s economic structure, however, technological substitution and digitized production methods to some extent suppress the persistence of wage growth, thereby reducing the probability of a fully formed wage–price spiral taking shape across the board.

IV. Where should U.S. Treasuries go from here, as they approach breaking the $4 trillion mark?

Despite these structural differences, the current macro environment also brings new risk factors. Today’s level of global public debt is clearly higher than in historical periods, and the fiscal burden brought by higher interest rates has noticeably increased. When responding to energy shocks, central banks face more complex constraints. As of March 2026, the total debt of the U.S. federal government has already surpassed $3.9 trillion. It expanded from $3.8 trillion to $3.9 trillion in only 5 months, and such an acceleration is not common in peacetime and non-systemic-crisis normal conditions. Behind the rapid build-up of debt are, on the one hand, structural pressures from long-term fiscal deficits and tax cuts; on the other hand, additional spending stemming from recent geopolitical conflicts. For Iran-related military actions, direct spending has already exceeded $12 billion, while the government is still applying for follow-on budget allocations of more than $200 billion, further raising the size of the fiscal deficit.

More difficult than the sheer scale of debt is the snowball effect of interest expenses. Based on current interest-rate levels, in fiscal year 2026 the U.S. federal net interest expense is expected to exceed $1 trillion, which is already greater than defense spending in the same period. Currently, the U.S. debt-to-GDP ratio has risen to around 120%. The longer the high-interest-rate environment lasts, the easier it is for debt expansion and interest expenses to fall into a cycle of issuing new debt to pay interest on old debt, making the test of fiscal sustainability only more severe. At the same time, uncertainty is also hidden on the demand side for U.S. Treasuries. Persistent high inflation keeps eroding the real return of Treasuries, weakening their traditional safe-haven attributes at the margin. On the foreign holdings side, at the end of 2025, Japan, the UK, and China—three major holders—reduced their holdings of U.S. Treasuries in tandem, reflecting structural concerns by overseas capital about the U.S. fiscal path. As the trend of de-dollarization and reserve diversification continues, once overseas demand weakens at the margin, U.S. Treasury yields will rise further and financing pressure will intensify accordingly.

Under the transmission chain of high oil prices, high inflation, and high interest rates, the risk facing U.S. Treasuries has evolved from a pure “scale” problem into a deeper structural issue. In the short term, U.S. Treasury yields will most likely remain at high levels with continued volatility, and fiscal pressure and market volatility will reinforce each other. In the medium term, U.S. policy space has been sharply narrowed: either reduce fiscal spending to bring down deficits, or in extreme cases rely on monetization to absorb debt. Both paths come with significant costs and constraints.

Against this backdrop, we revisited how the issuance scale of U.S. Treasury securities has evolved across past cycles of war and geopolitical conflicts, attempting to answer whether this debt-for-fight pattern is approaching a turning point. It can be found that the impact of war on U.S. Treasuries is not linear; it is more like an amplifier rather than a decisive variable. In most cases, it is not a single war expenditure that truly drives the jump in debt scale, but rather the macroeconomic cycle and institutional restructuring layered on top. Take the late period after the Vietnam War as an example: growth in the existing stock of U.S. Treasuries was relatively moderate, and new issuance mainly served the dual expansion of welfare and military expenditures, with war providing the “legitimacy” for deficit expansion. But what truly pushed the debt path upward was the reconstruction of the U.S. dollar credit system after the Bretton Woods system disintegrated. Similarly, in the Afghanistan and Iraq war phases, the net issuance of U.S. Treasuries surged several times, but the core driving force was also not limited to military consumption; more importantly, it was the countercyclical policy expansion in response to the subprime mortgage crisis.

From the perspective of yield pricing, war itself does not directly determine the direction of interest rates; the key is still the credit anchor and the monetary policy framework. During the Vietnam War, U.S. Treasury yields rose sharply not because of supply expansion, but because inflation spiraled out of control due to instability in the U.S. dollar credit system. The outflow of gold and the dollar losing its anchor jointly pushed up nominal yields, and war played a more catalytic role for inflation. By contrast, the Reagan-era experience is more comparable: in the 1980s, rapid expansion in military spending doubled the stock of U.S. Treasuries quickly, but against the backdrop of Volcker’s strong rate hikes and inflation expectations being re-anchored, the 10-year U.S. Treasury yield actually fell from around 15% to roughly 8%. This reflects the dominant role of monetary policy credibility in yield pricing, while the “oil–dollar–Treasuries” cycle gradually took shape. Trade surpluses from global oil-producing countries flowed back to the U.S., providing stable funding that enabled the U.S. to sustain larger-scale fiscal expansion.

Looking further ahead, in a rate-cutting cycle, war tends to reinforce—rather than weaken—the demand-side support for U.S. Treasuries. During the Gulf War, U.S. fiscal pressure was relatively manageable, and costs were shared by multiple countries. Meanwhile, the global economy was in a downturn and policy was easing, and safe-haven capital inflows combined with the rate-cut environment effectively offset upward pressure from the increased supply of government bonds. After entering the 21st century, this mechanism was further strengthened. In the war on terror period, the size of U.S. Treasuries expanded significantly, but because the Fed kept interest rates near zero for a long time and implemented quantitative easing, including directly purchasing government bonds to suppress long-end yields, the traditional constraint relationship between issuance scale and yields was substantially weakened.

After the Russia–Ukraine conflict in 2022, supply shocks combined with demand recovery pushed the world into a high-inflation phase. The Fed was forced to hike rates rapidly, and U.S. Treasury yields rose in a one-way move. In this stage, on the one hand, the U.S. supported external military and fiscal spending by issuing more Treasury bonds; on the other hand, it faced rising rolling costs brought by the rapid rise in interest rates, quickly magnifying pressure on interest expense, and even seeing a situation where net issuance on a single-quarter basis exceeded $1 trillion. Because inflation exhibited the characteristics of a wage–price reinforcement spiral, the reaction of interest rates to falling inflation lagged, keeping yields at high levels for an extended period.

It is precisely under this historical comparison that the special nature of the current environment begins to become evident. Unlike before, this round of conflict comes with a constraint combination of high oil prices, high inflation, and high interest rates. This may imply that the relationship among the issuance scale of U.S. Treasuries, financing costs, and market demand could potentially return to a “tightening in the same direction” state, thereby subjecting the traditional “debt-for-fight” model to even greater constraints.

V. How do major asset classes change under the re-inflation narrative?

In the current macro environment, the core logic of global asset pricing is shifting toward a structural framework with multiple constraints layered together. High energy costs, inflation persistence, and policy uncertainty jointly form the new underlying foundation for pricing. Even if there is no extreme supply disruption, as long as energy prices remain in a high range, inflation paths and the interest-rate center of gravity will be systematically pushed upward, and global assets will gradually adapt to a new normal of “high costs + high rates + high volatility.”

In past geopolitical conflicts, markets typically followed a path of “risk rising—capital flows into U.S. Treasuries—yields falling,” with U.S. Treasuries benefiting clearly as the core safe-haven asset. But in this round, the operating mechanism has already changed: the dominant logic is no longer safe-haven sentiment, but inflation and interest-rate constraints. After oil prices quickly surged to above $100, the market first corrected inflation expectations and the monetary policy path, rather than simply increasing safe-haven demand. Against the backdrop of compressed expectations for rate cuts and even renewed discussion of rate hikes, U.S. Treasury yields actually rose, reflecting the feature that the inflation shock overwhelms safe-haven demand. At the same time, U.S. federal debt is close to $4 trillion; at current interest-rate levels, interest expense is rising rapidly, and reliance on issuing debt to finance spending continues to deepen. Supply-side expansion layered with a high-inflation environment makes long-end yields more easily driven by the dual factors of “more debt issuance and rising inflation expectations,” and more difficult to be pushed down by safe-haven capital as in the past. Under this framework, the pricing logic for U.S. Treasuries is shifting from “safe-haven dominant” to “inflation and supply dominant.” The result is that renewed steepening pressure faces the yield curve, the long-end yield “center of gravity” is easier to move up than down, and the safe-haven attributes of long-term Treasuries are marginally weakening. By contrast, the benefit logic for gold is more direct: when inflation persistence, uncertainty about real interest rates, and credit concerns coexist, gold’s combination of safe-haven and currency-substitution attributes makes it more likely to receive sustained allocation demand.

If the conflict becomes prolonged but shipping corridors maintain nominal passage for trade, the typical performance of the oil market will not be “price hikes driven by supply cutoffs,” but rather a systematic increase in the risk-premium “center of gravity.” Ship insurance, escort and convoy costs, rerouting arrangements, and supply-chain buffer inventories will all raise marginal costs; the oil price “center of gravity” is likely to move higher and remain with elevated volatility. Looking further ahead, this shock will also reshape global energy trade routes: Europe and Asia will seek alternative sources outside the Middle East more actively. The strategic value of U.S. shale oil, Russian crude oil, and other regional supplies will increase. However, in the short term, global spare production capacity is limited and cannot fully replace the hub role of the Strait of Hormuz, so high oil prices are more likely to become a stage-level norm rather than a short-term spike. Under this scenario, the main line for commodities will shift from “demand cycles” back to “supply security.”

The changes in the foreign exchange market will be even more complex, and the U.S. dollar may show a “strong short, weak long” pattern. In the short term, liquidity advantages and safe-haven demand continue to support the dollar. But as fiscal constraints intensify and inflation pressure rises, the market’s reassessment of the dollar’s credit will gradually unfold. Structurally, the dollar’s share in global reserves has already clearly fallen from historical highs, and the trend toward reserve diversification continues to advance. In a context where energy and payment security are both emphasized, the use of non-dollar currencies in cross-border settlement may increase at the margin—especially currencies that are supported by trade and industry, such as the renminbi, which may have more upside potential.

In equities, global markets’ divergence may be further reinforced. The combination of high oil prices and high interest rates puts downward pressure on the valuation center of gravity, especially impacting markets that depend on low-interest-rate environments. U.S. equity assets may gradually move from the past high-valuation expansion phase into a new stage characterized by higher volatility, lower returns, and increased structural divergence. By contrast, markets with advantages in complete industrial chains and supply capacity may receive relatively stronger support under the logic of energy security and industrial restructuring. Hong Kong stocks may experience greater volatility due to flows from foreign capital, but when valuations are at low levels, their attractiveness to medium- and long-term capital is expected to improve.

Ultimately, the current asset-pricing system is undergoing a reconstruction of its underlying logic. The core is no longer only growth and interest rates, but the balance among energy costs, fiscal constraints, and monetary credit. In this process, the definition of traditional “risk-free assets” may become less rigid. Gold, energy, and some assets featuring supply-security and credit-stability characteristics will gradually obtain new sources of premium.

VI. Risk Warning

Risk of geopolitical disturbances; risk of uncertainty in Trump’s policies; risk that overseas rate cuts fall short of expectations; risk that the domestic policy implementation effect does not transmit as expected.

（Source: Galaxy Securities）